Strengthening financial institutions’ resilience has never been more important, say Gabriele Vigo and Olivia White at McKinsey.
The world is undergoing increasingly rapid, unpredictable, and unprecedented change. But across the financial services industry in Asia, most companies have remained focused on near- and medium-term earnings, typically assuming ongoing smooth business conditions. The Covid-19 pandemic heralds the need for a new approach.
Catastrophic events will grow more frequent, but less predictable. They will unfold faster, but in more varied ways. Think about the multiple waves of the pandemic – with its social and economic impact on various Asian countries and the companies that operate in the region. In the long run, the digital and technology revolution, climate change, and geopolitical uncertainty will also play major roles in creating new challenges for the region’s capital markets.
To thrive in the coming decade, financial firms must develop resilience—the ability to withstand unpredictable threats or change and then to emerge stronger. While “developing resilience” is easy to say, it is hard to define, and even harder to do. Yet, it is imperative for Asian companies to start thinking critically about the approaches they must take in order to withstand whatever comes their way in the future.
How new trends create new threats
While the digital revolution has improved the availability of data, connectivity, and the speed of decision-making, it also comes with potential for large-scale failure and security breaches. In fact, the rising cyber security threat was cited as one of the main reasons for the recent surge of data breach alerts received by Singapore’s data protection watchdog. These breaches increase the speed at which the reputation of a company – or even an entire industry for that matter – can change in the public eye.
On the other hand, the changing climate presents structural shifts to banks and other financial services’ risk-return profiles. They need to strike a balance between their immediate profit and pressures from governments, investors, and society at large. For Asian companies, this turns out to be particularly challenging, as regional ESG disclosure frameworks are not as well-established as those in the US and EU.
Finally, the uncertain geopolitical future provides the backdrop. The world is more interconnected than ever before, from supply chains, to travel, to the flow of information. That is true even for a fragmented market like Asia. And from what we observed over the past few years, most regional firms have not prepared to operate in an environment where these connections are abruptly cut. The worsening US-China tensions provide a case study on how political changes can easily upend long-held business practices.
Broad-based resilience beyond financials
Firms that are inflexible and unwilling to take sufficient risk will not respond or innovate to meeting changing circumstances. Those that are too focused on financials and immediate expansion may take on too much risk that can kill their long-term success. The financial services industry has developed specific resilience capabilities, but when front and back-office disruption occurs, “surprise gaps” that result from regulatory, behavioural and climate-related changes become visible.
Within the financial services space, most Asian companies, perhaps due to the region’s relatively strong economic growth over the past two decades, have thought about such risk–return trade-offs in financial terms, making sure they have the financial reserves needed to withstand some uncertainty around a single planning scenario. But today’s world demands more than financial resilience.
True resilience requires a balanced focus on six dimensions: financials, operations, technology, organisation, reputation, and business model. It’s critical that organisations start thinking in these terms as well.
As a prime example, climate hazards can threaten the sourcing, production, and distribution of products and services. In the era of global supply chains, these hazards can come from anywhere, so the owner of a Taiwanese semiconductor maker will have to make sure that each chip component has multiple vendors to source from in case disruption occurs. Ideally, they would also be based in different jurisdictions.
Moreover, financial services firms must take a stance on the role they want to play in reducing emissions, accounting for expectations from governments, employees, investors, shareholders, and society at large. As mentioned earlier in this article, Asia still faces challenges associated with a lack a standardised ESG reporting methodology. But the good news is with further standardisation and clarity of methodology, additional information made available, and increasing tracking and analysis of unreported data through artificial intelligence and machine learning, availability and quality of data will increase rapidly over time.
Internally driven change also requires a broad view of resilience. Consider a company-wide digital and analytics transformation at a bank, addressing both internal processes and product and service delivery to customers. While efficiency and the art of the possible expand, so does the potential for broadscale technological failures or massive cyber incursions. Employees need to develop new skills and different ways of working together. Analytics offers new horizons, but also can embed bias in decision making.
Financial services firms – including banks – that understand the resilience they need for the future can implement sensible change. In case of vulnerabilities, this may mean transforming in ways big or small to enhance resilience directly. But, as importantly, firms should look to build resilience into any transformation they undertake, regardless of the primary goals—from digital to growth to cost. This yields more robust change and helps you bake in resilience from the outset.
Building resilience for the years ahead requires an understanding of how resilient a company is today. To what degree and where do you rely on add-ons or trade-offs? How is resilience baked into the way you operate in normal times? Ongoing resilience requires embedding related considerations into day-to-day decision making as well as into strategy setting. Institutions should link this business-focused approach toward resilience to any existing enterprise-risk-management processes and should consider investment in anticipation and response capabilities.
An ideal design will maximise practices that make you stronger in normal times and better ready to withstand and adapt to threats. It’s hard to predict what the future might hold, so what are you waiting for? It is time to get started.
This article was contributed by Gabriele Vigo and Olivia White, both Senior Partners at McKinsey. Gabriele leads the firm’s Risk and Resilience Practice across Asia, focusing on banking, regulation, risk management and strategy. Olivia advises banks and technology firms on issues covering strategy, organisation, risk management, resilience, and operations.